Tuesday, December 23, 2008

Importance of Contractor Progress Payment Terms


Getting The Tender Right
It has been said that an army marches on its stomach. Contractors and subcontractors in the construction industry run on cash. Lord Denning many years ago made the oft repeated phrase that cash flow is the lifeblood of the construction industry and this sentiment is still relevant today. Estimators when preparing tenders usually concentrate on building profits into the price. Of equal importance is the amount of working capital required to fund the contract and the need to keep the amount to a minimum. The payment terms are therefore crucial to every contractor and subcontractor. Certification and payment should be the subject of careful strategy and planning.

Mobilisation payments are common on overseas projects and should be considered by estimators on home based contracts and proper provision where appropriate included in the tender. The cost of manufacture is often greater than onsite erection but many standard contracts do not provide for certification and payment until the goods have been delivered to site. The reasons are historic in that when these contracts were first drafted many years ago there was very little offsite manufacture and fabrication. Many contracts drafted more recently however recognise that there are substantial costs which may be incurred prior to a start being made on site. The same principle applies to the design costs.

Many years have passed since Architects designed work undertaken by specialist subcontractors. Collateral design warranties became widespread due to the design of specialist installations being passed down to the specialist subcontractor. These early design costs need to be recovered as soon as possible usually long before onsite erection has commenced. When preparing a tender it is therefore essential for proper provision to be made for certification and payment for design and offsite manufacture when the costs are incurred and not many weeks of months later. The specialist subcontractor needs to stand firm when these provisions are challenged by the main contractor or the Employer’s consultants.

In contract negotiations price and performance are usually of more importance to the Employer as the money to pay for the project has usually already been allocated and it is a matter of timing as to when it is called down.

Improving On Going Contractor Payments
Most standard forms of contract provide for monthly payments which are based upon the value of work completed in the previous month. The process of valuing work on a monthly basis can be time consuming and therefore in recent years there has been a move to introduce milestone or stage payments whereby a pre-agreed sum is paid only when work has reached a certain stage or milestone. This information is usually provided at tender stage by the tenderer who needs to invest time and effort into ensuring that the stage or milestone payment plan is calculated to maximise cash flow. Employers who use the normal JCT forms of contract are rarely advised of the risk allocation which is prescribed in the contract.

No provision is usually made in Employers budgets for the possibility of cost overrun. When as a result of variations and delay and disruption claims this becomes a reality the payment shutters come down and receiving money for this type of item becomes very difficult. Contractors and subcontractors often do nothing to help themselves.

Final valuation of variations and delay and disruption claims isn’t given a priority status and can be very damaging to cash flow if left until the work on site has been completed. Time is often saved if variations are finally valued at the time the work is being carried out and delay and disruption claims at the time when these events occur. Getting the additional cost of variations and delay and disruption claims agreed and paid has created a problem for contractors and subcontractors for as long as anyone can remember.

There is no need to suffer for very long in view of the provisions of the Construction Act 1996 which came into force on 1st May 1998. Adjudication which is provided for under the Act is now available at any time to both parties to a construction contract. It takes less than a week to have an adjudicator appointed and his or her decision must be published within 28 days thereafter. With a few exceptions these decision are enforceable by the Courts. In excess of 6000 adjudications have been heard since the Act came into force, the majority of which have been commenced by specialist subcontractors who consider they have been underpaid. Often the threat of adjudication is sufficient to enable meaningful negotiations to get under way.

Remedies For Late or Non-payment
The Construction Act has been a blessing to specialist subcontractors. Not only does it provide facilities for referring disputes to adjudication but it outlaws pay when paid clauses. These clauses allow the main contractor to delay payment to the subcontractor until the money is received from the Employer and to avoid payment to the subcontractor entirely if the money isn’t received from the Employer. Since the coming into force of the Act the only pay when paid clause permitted is in respect of non-payment due to the insolvency of the Employer. A further benefit included in the Act provides that if payment is not forthcoming in accordance with the contract terms the contractor or subcontractor may subject to proper written notice suspend work until payment has been received. When money is in short supply often the companies who threaten to suspend work are the ones who receive payment first particularly if the work is on the critical path. If payment is made late interest becomes due on the outstanding money in accordance with Late Payment of Commercial Debts (Interest) Act 1998 which applies to all contracts as from 1st November 2002. The rate of interest payable is 8% above bank minimum lending rate unless the contract itself provides a substantial remedy for late payment. This contractual remedy to be regarded as substantial would have to be in the region of an 8% interest rate. If properly applied these statutory provisions can often substantially improve a specialist subcontractor’s cash position.

Benefits of Partnering
It has been argued that many of these problems are removed on Partnering Contracts. If this is the case many specialist subcontractors are still still waiting for the benefits to filter down and in the mean time may prefer to apply the “Cash is King” policy.

Source: http://www.longworthconsulting.co.uk/news%20construction%20contract%203.htm
Note: English and Scots Law Cases in Construction Contract Disputes & Adjudication


The Process

The Certification process in the construction industry has been in place for many a long year and is an integral part of both building and civil engineering. It involves client, consultant, main contractor and subcontractor alike. The very existence of large numbers of companies who make their living in the construction industry depend upon the certification process. On many standard forms of main contract the contractor is entitled to be paid the sum which is certified by the Architect, Engineer or Contract Administrator. Main contractors in an effort to ensure that they do not finish up paying out more than they receive link the payment under the subcontract to the amount certified under the main contract. The widely used standard forms of contract published by the JCT and ICE provide for the Architect, Contract Administrator or Engineer to issue a payment certificate at regular intervals normally monthly which under the terms of the contract is the sum which the Employer is required to pay. Where any form of advanced payment or payment on account is involved there is always a fear on the part of the paying party that there may be an overpayment followed closely by the insolvency of the party who has received payment. Where this occurs the paying party is usually left out of pocket. Architects and the Quantity Surveyors who provide the necessary financial advice, Contract Administrators and Engineers are only too well aware of the dangers of over certifying. Employers who find themselves in the position of having overpaid a main contractor who subsequently goes out of business are usually never slow to argue that the over payment has resulted from negligence on the part of one or more of its consultants and are quick to threaten legal action to recover the overpayment.

Unilateral Action

Often Employers take matters into their own hands having received a payment certificate and take unilateral action to reduce the amount certified before making payment. Employers who take the decision to reduce the amount certified often fail to realise that it is not just a simple matter of sending off a cheque in a reduced amount. The Housing Grants, Construction and Regeneration Act 1996 put a stop to that method. One of the objects of the Act is to assist cash flow in the construction industry and so includes a procedure intended to make it a little more difficult to avoid paying sums when they are due. Section 110(2) states that a party to a construction contract may not withhold payment unless an effective notice to withhold payment has been made. To be effective the notice must state the amount which the Employer intends to withhold and the reasons for it being withheld The contract must provide a timescale within which the notice must be served before payment is to be made.

Legal Scrutiny

The withholding by the Employer of sums certified came under review in the recent case of Rupert Morgan Building Services Ltd v David Jervis and Harriet Jervis (2003). Work was undertaken by the claimant on a cottage owned by the defendants, the conditions of contract used were those issued by the Architecture and Surveying Institute. These conditions provided for the defendant to pay the claimants sums which had been certified by the Architect who had been appointed by the defendants. A dispute arose out of the payment of the sum included in Certificate No 7. The Architect certified as due for payment a sum of £44,000 plus VAT of which the defendants disputed £27000. It was argued by the defendants that the amount certified included items for which payment had already been made. In time honoured fashioning the defendants merely sent off a cheque in the reduced amount. It is unlikely that they were familiar with the requirements of the 1996 Act and due to a lack of the necessary withholding notice the claimant applied to the court to enforce payment in full of the sum certified. The case finished up in the Court of Appeal who had the task of wading through a number of cases which involve reviewing the circumstances under which a withholding notice in accordance with the 1996 Act is required. It has to be said that the decisions handed down by the courts on this matter lack consistency. There is what is referred to as the narrow and alternatively the wider interpretation of the wording. The Act refers to the notice being required in respect of a sum which is due under the contract. It is often argued in accordance with the narrow interpretation that if some or all of the work for which payment is sought has not been carried out in accordance with the contract then payment cannot be due. This being the case the need for a withholding notice does not arise. The wider view is that payment properly applied for under the contract will have to be made in full unless a proper withholding notice has been served.

Court Explains

The Court of Appeal avoided deciding whether the narrow view or wider view was correct. The opinion however was expressed that if the narrow view is taken as being correct then there is a fuzzy line between claims for breach of contract such as delay which require withholding notice and abatement, which reduces the value of work carried out, which does not. To get round this difficulty the Court of Appeal decided that the sum due under the contract was the amount which has been certified by the Architect. This being the case the narrow view argument used by the defendants that the sum wasn’t paid because it wasn’t due could not apply.
It seems in view of what was said in the Court of Appeal concerning the narrow and wider interpretation of the circumstances when a withholding notice is required that commercial common sense needs to be in place at all times. It must always be good policy for the paying party to send a withholding notice as required by the contract if the intention is not to pay the full amount of sums certified or where an application for payment is made the intention is to pay a lesser sum.

Source: http://www.longworthconsulting.co.uk/news%20construction%20contract%207.htm